Global Growth Woes – Here Is Where the Blame Lies

Michael Ivanovitch | President, MSI Global

Sunday, 18 Nov 2012 | 10:39 PM ETCNBC.com

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When, towards the end of World War II, the British economist John Maynard Keynes led his country's delegation to negotiate in Bretton Woods the IMF's charter (articles of agreement), he argued that the stability of the international monetary system and world economy required that surplus and deficit countries should be held equally responsible to balance their trade accounts.

Keynes feared that America, relatively unscathed after nearly five years of brutal conflict, would be flooding Europe with its exports, creating a shortage of dollars and obstructing the recovery of a starving and war-ravaged continent.

As it turned out, Keynes's worries about the possibility that America would selfishly pursue mercantilist policies were misplaced. Washington quickly moved to help Europe get back on its feet with a $13 billion Marshall Plan (formally known as the European Recovery Program) and kept its markets open for European goods and services.

During the three years of the Marshall Plan, the economies of 17 European countries benefiting from its assistance grew between 15 percent and 20 percent, and, largely as a result of growing imports from Europe, the U.S. trade balance recorded its first postwar trade deficit of $2.3 billion (0.2 percent of GDP) in 1971.

The US Remains Engine of World Economy

The U.S. is still the largest buyer of goods and services produced around the world. In the first nine months of this year, America's trade deficit with China, Japan and Germany accounted for nearly two-thirds of its $559 billion trade gap.

Keynes must be turning in his grave: Even with a feeble 2.3 percent GDP growth, America is the engine of world economy, while the second, third and fourth-largest world economies are living off their trade surpluses with the U.S. and the rest of the world.

Those wondering about what went wrong with the world economy should look no further. With their huge trade surpluses, ranging from $86 billion (Japan) to $217 billion (Germany), these three countries – one-fourth of world GDP – are making no net contribution to global economic growth. Worse: they are, in fact, a drag on world economy.

And there is no end to this. Almost by design, Japan and Germany are export-led economies. Neither country wants to abandon this growth strategy by generating more demand and output from their domestic spending. China apparently wants to get off the export bandwagon, but it will take some time to significantly change the composition of its economic growth.

Japan's Structurally Weak Domestic Demand

In terms of Keynes's argument for symmetry in trade adjustment obligations of deficit and surplus countries, Japan has been – and still is – the most difficult case. Over the last 10 years, for example, about one-half of Japan's economic growth came from its trade surpluses. During that period, exports - 8 percent of GDP - grew at an average annual rate of 6 percent, while household consumption – 60 percent of GDP – edged up only 0.9 percent.

These numbers clearly show that it is almost impossible to grow on the basis of domestic demand if its largest component is in virtual stagnation. And Tokyo is not doing much to change that. Ever since the "bubble economy" burst in the early 1990s, a succession of Japanese governments chose to finance public sector investments – about 4 percent of GDP – by building the proverbial "bridges and highways to nowhere" instead of stimulating household consumption. No wonder the economy largely stagnated over the last 20 years with an average annual growth of less than 1 percent.

Admittedly, it is difficult to stimulate private consumption in an economy with declining and rapidly aging population. A study, published last January by Japan's National Institute of Population and Social Security Research, forecasts that the country's population will shrink by one-third over the next 50 years as a result of an alarmingly low birthrate of 1.39 per woman of childbearing age. The study also shows that, at this point, it looks like a mission impossible to even slow down the population decline, because Japan would have to raise its birthrate to 2.1 per woman.

It is obvious that to stabilize the economy Japan would have to address, with a great sense of urgency, the problem of its worsening demography. Only a steadily rising trend in net family formation and birthrates would underpin private consumption and residential investment (63 percent of GDP) to gradually wean the economy off its excessive dependence on export sales.

But that, unfortunately, does not seem likely anytime soon. Barring more dangerous developments in Sino-Japanese relations, Japan's sinking exports to China (down 14 percent in the year to September) will just be dumped somewhere else.

China's Slowly Changing Growth Patterns

China will probably do better than Japan in changing the current structure of its economy. With an apparent determination to anchor economic growth around household consumption and investments, Beijing wants to minimize trade frictions with the U.S. and Europe as it becomes one of the key players in world commerce and finance.

These changes will take time, though. One has to remember that most of China's manufacturing sector was set up to serve exports, based on low wages and a favorable tax treatment of joint ventures with foreign companies.

Still, some important changes are happening already. Rapidly escalating wage and non-wage labor costs are making China increasingly expensive as a manufacturing export base. Some European companies are even repatriating their manufacturing from China due to the shortage – and rapidly rising costs – of skilled labor.

China's current growth patterns are also likely to change as the planned reduction of large income inequalities and a more extensive welfare system – two of China's new leader's top priorities – are likely to stimulate household consumption (a relatively small 35 percent of GDP) since families would have to save less for education, healthcare and retirement.

And while these structural changes are taking hold, China's trading partners could sell more of their products and services by insisting on better access to Chinese markets. Beijing will have to yield because its own companies are seeking to establish trading and manufacturing positions in various countries around the world.

Obama's Wrong Number in Europe

While China's large trade surpluses are a relatively recent problem, Germany's systematically export-led economy has been a destabilizing factor for Europe and the rest of the world since the early 1970s.

President Obama learned all about it when he was trying to rev up the U.S. economy during his election campaign. Apparently thinking that he solved former U.S. Secretary of State Henry Kissinger's ld riddle – "Who do I call if I want to call Europe" – Obama hit the wall when he rang up that number in Berlin to ask for less austerity and more economic stimulus to protect one-fifth of American exports to the E.U.

Not only did the German Chancellor Merkel refuse to oblige, but she also haughtily dismissed American entreaties by saying that "it made no sense to be adding new debt to old debt." And all that from a lady Obama decorated with the Presidential Medal of Freedom, America's highest civilian honor, in June 2011.

But Obama was right to ask Germany to buy more from its trading partners, because Germany had plenty of room to stimulate the economy and stop living off the rest of the world. With a virtually balanced budget, record trade surpluses (6 percent of GDP), stable and low inflation, and borrowing costs of its public sector at a record-low 1.3 percent, Germany should temper its austerity mantra and buy more goods and services from some of the hard-pressed and heavily indebted euro zone countries.

Germany, of course, won't do that. A low unemployment rate, and a relatively placid social scene, will again allow Germany to ride out the euro zone recession on the back of exports.

Don't Hold Your Breath for the G20

What can be done about the fact that 25 percent of the world economy makes no net contribution to global economic growth and acts as a drag on the economies of its trading partners? The answer is: not much, if anything.

The irony is that the world has a forum to deal with such problems. The G20 – a group of the world's 20 leading economies, representing 90 percent of global GDP and two-thirds of the world population – has been set up to promote economic growth through better coordination of economic policies. In other words, through policies designed to reduce destabilizing trade imbalances in the world economy.

The need to implement better coordination of macroeconomic policies was one of the key decisions of the G20 meeting in the Mexican resort of Los Cabos last June. And what happened?

The G20 sherpas (representatives of the heads of state and government) had nothing to say about that when they met in late October to monitor the implementation of their bosses' decisions, because there were no coordinated policy measures to support the weakening world economy undermined by excessively unbalanced trade flows.

The sherpas nevertheless congratulated themselves on the "good work" and passed the baton to Russians who will take on the G20 presidency next January.

But expect no more to be done in the imperial splendor of Saint-Petersburg's Constantin Palace in September 2013 than the repeat of empty talk – at great taxpayers' expense – of previous meetings.

That will suit Beijing, Tokyo and Berlin just fine. As in the past, they know they can bet on one thing and win: Driven by an extraordinarily loose monetary policy, the U.S. economy will continue to be their main export market for the foreseeable future.

Michael Ivanovitch is president of MSI Global, a New York-based economic research company. He also served as a senior economist at the OECD in Paris, international economist at the Federal Reserve Bank of New York and taught economics at Columbia